Odd Lots - Why a Natural Gas Company Is Shaking the World of Islamic Finance

Episode Date: July 3, 2017

Earlier this month, Dana Gas, a UAE-based company, rocked the world of Islamic finance by announcing that one of its Shariah-compliant bonds was, well, no longer Shariah-compliant. On this week's episode of Odd Lots, we speak to veteran Dubai-based journalist Frank Kane about the rise of Islamic finance (what it is, how it works, why it's grown so fast) and why the Dana Gas announcement is such a big deal.See omnystudio.com/listener for privacy information.

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edition of the odd lots podcast i'm tracy aloway and i'm joe wisenthal so joe do you remember um we had on one of the authors of that 3 000 page book called a history of interest rates oh yeah that was a really uh that was a really early episode and a really good one yeah everyone should go back and and listen to that one, by the way. But I'm curious, did you ever actually read the book? Should we pause here and give people some time to go back and listen and then like resumes? No, we're going to keep going. Answer my question. Did you actually read the book? No. No, I want to, but it is huge. It is a massive, I mean, I'll read it one day, but no, I'm not going to lie. I haven't read it yet. Okay, well, the secret is most of it is charts, but you should still read it because it's really good.

when I read it, I thought one of the most interesting things in there was actually a history of interest rates. I guess that's obvious, but a history of moral attitudes towards interest rates. That is really interesting because we tend to think about, you know, just interest rates as being these things that are sort of mechanically set by conditions in the economy and so forth. But we know that at the edge of things, things like usury, payday loans, we do have caps that we consider to be excessive on interest rates and different cultures at different times have had different views on borrowing. Yeah, and different religions too. Although actually,

a lot of the most major religions have very, very unfavorable opinions of usury. So if you go back and read the Bible, for instance, I'm pretty sure there are some passages in there that basically tell you you shouldn't be putting any money in a bank. That's interesting. I should read that. We should find those passages. Okay. So I've, I've just given you like a week's worth of reading homework. The reason I bring it up is because one of the religions that's probably most famous for having an unfavorable attitude towards charging interest, to put it mildly, is Islam. And there's a whole industry that's been created around that notion to basically allow people to invest in certain assets and to put their money in banks without charging interest. and breaking a primary concept of Sharia law.

Right. So from what I understand, and to be honest, I don't understand very much. But the Koran lays out, I believe, some rules about how avoiding interest. So then there's an attempt to create financial instruments that avoid violating the Quran but serve a similar purpose to bonds and borrowing. That's right. And the reason we bring it up is because something really interesting actually happened in the world of Islamic finance just a couple weeks ago. And we're going to have someone on who's watched the development of Islamic finance over the past, I mean, almost a decade, really.

And he's going to explain to us how this industry really grew and what the most recent event might mean for the industry. Let's do it. So our guest today is Frank Kane. He is senior business columnist for Arab News. He's also a veteran business reporter at the National, and he's been in Dubai for a very, very long time. Dubai is, of course, a center of Islamic finance, and he's going to break it down for us.

So, Frank, thanks so much for joining us. Pleasure. Thank you. Thanks for having me. I've been here 10 years, by the way. So, yeah. Islamic finance has been here for considerably longer than 10 years, but I think it's fair to say that it has taken off in the last decade or so, and especially

since the global financial crisis 2009, which, as we all know, began as an infection in the Western banking system, asset-related infection, and which ended up bringing down, almost bringing down the world financial system. And of course, this also affected this part of the world very serious. Dubai almost went bust. It was helped out by its brothers down in Abu Dhabi. But many Islamic financial commentators, after the global financial crisis, pointed to the fact that this was all the fault of conventional capitalism, of conventional finance, and that if there had been an Islamic financial system in place, it would not have happened.

Because Islamic finance is less risky than a conventional finance. than conventional finance. It is backed by real assets. You wouldn't have had very high-risk, low-quality assets that thought about the global financial prices. Those couldn't have happened. You couldn't have borrowed against them. So therefore, the idea was that if the global industry took more notice of Islamic financial precepts, we'd be a lot safer. That was given a big boost in 2013, in Dubai in particular, when His Highness, Sheikh Mohammed bin Rashid on Mukhtun, the ruler of Dubai, declared the ambition of the Emirate to be what he called the capital of the global Islamic economy. In three years since His Highness declared this goal,

Dubai has boomed as a centre for the Islamic economy, and that's kind of where we are now. All right, well, let's take a step back for a minute because that was a really good overview of Dubai's ambitions in Islamic finance. But walk us through what the goal of Islamic finance actually is. Joe and I talked about it a little bit in the intro, but give us some more detail. Right. And sort of what I'm curious about is to what extent is it about finding loopholes to create things that are not interest but sort of serve as interest type payments? And to what extent is it a, are they about fundamentally different types of financial instruments? Okay. Well, look, I mean, I must tell you straight up that I am not an Islamic scholar. I do not issue fatwares. If I could issue fatwas, I would not be a financial journalist on the pittance that I'm earning here.

So, I mean, I will give you my amateurs view. and it all goes down really to what is interest in conventional finance. Interest is the profit that money makes itself. That will not wash in an Islamic system because money cannot make a profit. Only assets can make a profit and money is not regarded as a physical asset. So interest in Arabic is called Riba and it is haram, it is forbidden. But instead, it's replaced by a profit share, and there's nothing wrong with profit shares. There's nothing wrong with sharing the fruits of labour or your sound management of an asset.

There's nothing wrong with that, sharing that profit. So that's what replaces it. But the reason they're allowed to make such big claims for the risk-free nature and the ethical nature is that assets have to be backed by, sorry, all properties have to be back by real assets. There has to be something behind them. So that's why they're able to say that it's less risky. And, you know, I mean, there haven't been huge runs on Islamic financial institutions in the past

in the way that they have been on Western institutions. So to that degree, you know, maybe they have a point. There is also another point that, you know, it's well worth making, there are 1.4 billion Muslims in the world. And if you can appeal to them to put their money into an Islamic financial institution rather than a Western conventional institution, then that is a very big market.

So you can make a lot of money out of it. And I think that marketing aspect of the whole concept of Islamic finance is very important. But it, you know, it is a valid thing. It is an alternative way at looking at finance. Before we get to the recent story that's been in the news, I want to go back to something that you said in the beginning of your answer when you said, you're not an Islamic scholar. You're not in a position to issue fatwas and you're on the sort of measly salary as a journalist. Yes, I'd like to underline that, Joe, if I could. I conclude from what you're saying then that within the Islamic finance industry, there is a role for the people who are in position to declare that a specific instrument is Islamic finance compliant, and that that seems like it must be a somewhat critical and therefore lucrative role in the whole thing.

Yes, you're dead right. And that's a very good point to make. and that in some ways gets to the heart of the thing that we're going to talk about a bit later. So the people actually make decisions are called scholars. They are experts in Islam. Most of them have a level of expertise in finance and accounting too. Combine these together and you get an Islamic scholar. These people are very well paid indeed.

There aren't that many of them. Around about 2013, there was an absolute rush around. the world by Western banks who sought potential for Islamic finance and they went hiring these guys on, you know, big, big bucks. In many cases, there was just one man sitting in an office in Wall Street with a stamp that was his fatwa stamp. That was his authority to declare that deal Islamic compliance, Sharia compliance. But they made an awful lot of money. And it was a very limited pool of people. And of course, you can see with, you know, with this sort of small number of people making decisions,

they can each go their own way, there's no unified structure to it, or rather that there are too many structures to it. So, and that really, you know, is part of the problem, really. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe

fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. That's vanguard.com All investing is subject to risk vanguard marketing corporation distributor. All right. Well, Frank, you've led into the recent news event perfectly. And what it is, let me try to break it down for our listeners who haven't been following all the business news emanating from the Gulf region recently. There's an energy company called Danigas, and it's based here in the UAE. And I think about five years ago or so, it issued 700 million worth of Sharia.

compliant debt, Sukukes. Now, since that time, the companies had a little bit of trouble getting payment from some people that owed it money, some producers, I think one of them was in Iraq. And so it's had to restructure its debt. Now, a couple weeks ago, Dana basically announced that its Islamic bonds, these 700 million worth of debt that have been sold in 2013, were no longer Sharia compliant. They were illegal. And because of that, they would be redeeming them and swapping them for something else. And this spooked a lot of investors, to put it mildly, right, Frank? Yeah, yeah, it did indeed, because, I mean, it's kind of unprecedented. I think there is one other case of Sukk being declared Haram, but it was a much smaller one, and it was a long time ago,

and it didn't involve the same principle. But basically, they said, look, it, Was your ear compliant back then when you stumped up, but now it isn't, so therefore we don't have to repay it, or rather we will make other arrangements to repay it. It turns out on less favourable terms than the original Sukuk. So naturally, bondholders, Sukuk holders, the same thing in these circumstances, they weren't very happy about this, and they sought enforcement of their claims to repayment. There were two more installments due this year. The court in Sharjah, which is one of the eminence of the UAE, said, no, you can't enforce this

until we reach a decision on whether this is Sharia compliance or not. So we're in kind of a, you know, a theft stick situation at the moment. They can't enforce until the court says whether they are Sharia compliant or not, and that won't happen until about December. But what they said in their explanation was that due to a change, interpretation that these were no longer Sharia compliance. And I think that that's what spook people, because they had suddenly declared the whole thing, you know, in retrospective to be no longer valid.

And people who had taken out these Sukukh thought, well, okay, if the law has changed, people have every right to change their minds, the lawyers can change their opinion, interpretations can change. But surely there is a legal and moral argument that these repayments have to be met on the same terms. And that's why people are worried. You basically anticipated my next question. Actually, I have like a million questions now based on that explanation. But I'll sort of rattle off three quick ones and you can sort of pick and choose.

The first is, so A, the company can do it? Can the company do it unilaterally just to clear? clear that the bond or the Sukuk is no longer Sharia compliant. B, do they need to get a ruling from one of the same scholars that declared it Sharia compliant in the first place? And then finally, what's been the market reaction to the whole industry if there is a precedent set that at any moment a financial instrument that was deemed to be compliant is suddenly just like, nope, we change our mind?

Well, that's what they did. The civil court, sorry, the Sharia court in the UAE Emirates here, Sharjah, will decide whether that was the correct procedure or not. Now, they obviously took advice, both from Islamic scholars and from lawyers, who would have a heavy Sharia element to them. So they did it on advice. That's the line. number two was, just remind me again, do they need to get an opinion from a scholar who deemed it Sharia compliant in the first place? Well, we're a bit in the dark on this because they haven't really explained, you know, broken down the process,

and they haven't really told us that. They said simply that it was a changing interpretation. Now, look, you know, maybe they have discovered something that was Sharia compliant in 2013 when they issued bonds and which no longer is. But the answer is we don't really know. We're waiting to hear all that. Lots of this will come out in court, in Sharjah, in Arabic, towards the end of the year. So we're not entirely certain. Now, in terms of market reaction, you know, people have been worried because this could happen to, you know, many others. It's, as you said, it's the precedent setting, which seemed to be the issue. If this can be changed so arbitrarily, you know, then where does that leave

all the other, you know, hundreds of billions, trillions of dollars worth of Sukk debt that's out there in the world? So one of the solutions to this that people have been proposing, including yourself in one of your recent columns, is to standardize some of the fundamental requirements of Sukuk's and Islamic finance. And I can see the benefits of doing that for sure. But then I think that Islam itself is a religion that is very open to interpretation. Yes, you have the Quran, but you also have the Hadiths, you have Islamic scholars, all issuing their own sets of advice.

It's very open to interpretation. So how realistic is it to actually standardize Sharia finance? Well, I don't think it is really. you know, to standardize it on a global scale at all. The two big centers of Islamic financial and economic activity in Southeast Asia and here in the Gulf in the Middle East, Malaysia in particular has been the most developed of the Islamic financial and economic markets. And Kuala Lumpur has done a fair job of making itself the Asian capital for regulatory standardisation of Islamic matters and bombs in particular.

The Middle East, on the other hand, however, even in Southeast Asia, the Indonesians do not have to recognise decisions of the Kuala Lumpur authorities, but they are relatively small, so it doesn't always matter. However, in the Middle East, which arguably is a bigger market, potentially more assets here, and a bigger, well, a comparable population. You would think that Saudi Arabia, Bahrain and the UAE between them, those are the three leading Islamic centers here in terms of finance, you would think that they between them would be able to get together

and organize something called the Gulf Fatwa Authority, the Kaliji Fatwa Authority, or something like that, so far that has alluded them. Bahrain seems to be the regionally recognized center for regulation. The UAE, as part of its drive to be the capital of the Islamic economy, also attempted to put in some unification of regulatory standards here. Saudi Arabia, which you would have thought had the sort of moral Islamic claim and being the biggest economy, you would have thought that they would have led the way, but they don't seem

to have, as yet. So these three centers are pulling against each other, and they have not managed to organize themselves into a single unified, unitary regulator. It is difficult. It is difficult. To the different regions, countries have fundamentally different objectives. Like what is the sort of, where are the dividing lines? Why is it so difficult? Because they have their own way of doing things.

and I guess that there's a proprietary element to it. They want to keep their own systems in place. They want to have their own regulatory standards. The comparison that has been made to me in the past is with halal food. Halal food has to adhere to a certain minimum standards in preparation and storage, wherever it is in the Islamic world. But halal food in Kuala Lumpur will look and taste very different from halal food in Saudi Arabia or Lebanon.

So, you know, it's taste, you know, really. You know, it goes down sort of global taste standards. And, you know, similar kind of things apply in finance too. Practices have grown up over years that have been accepted as standard by the people in Malaysia. Different standards have pertained in Bahrain. And they have diverged. And they don't want to have to pull them back.

You know, there is no, as Tracy said, that, you know, there's an awful lot of interpretation in Islam. And, you know, the financial regulatory systems reflect that. So, Frank, when you talk to people on the ground here in Dubai, how much concern are they expressing over the Stannogas situation? And how do they see it actually playing out? Well, they think that it can damage the Islamic economy and that it can damage. Dubai's attempt to be the, you know, the center of the regional Islamic system. Now, how it plays out, the court, I'm sure, will be lobbied by Islamic financial people in the course of the next few months.

Different interpretations will be put. The court in its Sharia wisdom will decide. I mean, there must be room for some elements of compromise. personally, if Darner were to sweeten the terms of the replacement Suk, you know, which they are offering, that's a fairly straightforward commercial decision by then. If they were to do that, then, you know, we could be halfway there and the whole episode could be left behind. All right. Fascinating conversation. Frank Kane really appreciated you coming on. I had read several pieces about this, and I think I have a greater understanding now about what's going on than I had.

for many of those. So really appreciate you joining us this week on Oddlod. Thanks a lot. So, Joe, one of the reasons I'm so interested in this whole saga, it's not just because I'm here in the Gulf, it's also because a lot of these arguments are being mirrored in other Western bond markets throughout the world. So you know you have these big movements for green bonds, for impact investing. And you're really seeing the same discussions, like should we standardize? the requirements for something to be labeled a green bond. And what exactly are we trying to achieve through impact investing? And everyone has different interpretations of what that is. So a lot of what we're talking about when it comes to Islamic finance, you could extrapolate to some other

hot new areas of the financial industry. You know what it made me think about? And this is not meant to be alarmist or anything, but I was thinking about the role of the Islamic finance scholars issuing the approval of Sharia compliance and thinking about that similarity to the role of the ratings agencies pre-crisis. And then the idea that suddenly, you know, of course in the U.S. suddenly a AAA is in the AAA anymore, suddenly a Sharia compliant. Financial Sukuk is no longer Sharia compliant anymore. So, you know, I don't, I have no reason to think it's going to spiral or anything the same way our situation did. But it did feel to me like sort of a slightly analogous situation.

Yeah, I guess it's a totally unexpected development, right? You think something is AAA, you think something is Sharia compliant, and then suddenly it isn't. It's not. Yeah. No, I really, that was very interesting. All right, shall we leave it for today? Let's leave it there. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Jill Wisenthall. You can follow me on Twitter at the stalwart. You can also follow Frank Cain at Frank Cain, Dubai.

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